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Sunday, March 10, 2002 - Page updated at 12:00 AM

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Dark days at City Light: Seattle utility was ill-prepared for a chaotic market

Seattle Times staff reporters

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Seattle City Light customers are stuck with a mountain of new debt — about $2,000 apiece — and electricity rates nearly 60 percent higher because their utility was not prepared for last year's energy crisis and slow to respond once it occurred.

City Light's debt stands at a staggering $1.7 billion, electricity bills have increased by an average of $27 a month, and there's no relief in sight.

Superintendent Gary Zarker and his staff members contend City Light was the victim of a "perfect storm" — roiling energy markets combined with a severe drought that cut the utility's electricity supply from its dams nearly in half.

But a Seattle Times examination shows City Light was poorly positioned to weather a market storm, let alone the "perfect storm" of 2000-01.

Its strategies were ineffective, its oversight by the City Council was lax and uninformed, and when deregulation tossed California's energy markets into turmoil and led to shortages and skyrocketing prices, City Light, unlike some other Northwest utilities, missed clues and didn't respond quickly enough.

The result?

City Light spent $737 million buying power in 2000-01. It was an astounding increase: In the previous two years, City Light spent just $86 million on the energy market. To put the last two years' electricity expenditures in further perspective, the entire city budget this year is $640 million.

Another result?

City Light's total debt of $5,005 per customer is up from $2,975 per customer two years ago, when City Light's debt was already the highest among Northwest public utilities. In effect, roughly half of your electric bill will be going to pay off debt this year.

The series


Today

The crisis: Seattle City Light was poorly positioned to weather the storm.

Tomorrow

The leadership: Some say the City Council should relinquish oversight of City Light to an independent utility board.

Tuesday

The reforms: What needs to change to make sure City Light doesn't repeat its mistakes.

Already had high debt

City Light always borrowed to pay for machinery and upkeep. The policy spread costs over many years, like an installment plan, and helped keep rates down. But last year the equation changed: For the first time, it borrowed to buy power.

After four increases last year, the monthly bill for an average residential customer using 1,000 kilowatts of power jumped to $72.35 in October from $45.46 in December 1999. Rates, though 26 percent below the national average, are forecast to remain high through 2004.

And another rate increase beyond the 58 percent jump is being considered.

Zarker acknowledges he was naive. Not about City Light's practices — he said they were sound. But naive about believing the Federal Energy Regulatory Commission (FERC), which by law is supposed to ensure just and reasonable rates, would cap prices when they got out of hand.

As the turmoil churned in California in 2000 and wholesale prices jumped from their historic lows of about $20 a megawatt hour, FERC commissioners repeatedly said they supported deregulated markets and would not cap prices.

But Zarker believed — and bet — they would.

"All games require rules and referees and these people were not doing their job," Zarker said of federal regulators.

"If you are a little slow to understand that the referees are going to let the other team play with more players, you are going to get your butt whipped."

Some utilities did better

To be sure, nearly every utility in the Northwest was hit hard by the crisis, but not all were affected equally.

Puget Sound Energy and Portland General Electric, both investor-owned utilities, made money during the crisis because they had surplus power to sell. They, too, had trouble from buying so much expensive energy. But rate increases, proposed or enacted, didn't go as high as Seattle's.

Tacoma Power, a municipal utility, had drier reservoirs than Seattle. Yet its managers planned more conservatively than Seattle, noticed deregulation shock waves sooner, and moved more quickly to limit its exposure to energy markets, abandoning business as usual.

"We were seeing weird things, like $60 a megawatt power in California in May (2000)," says Mark Crisson, director of Tacoma Public Utilities. "We were just kind of scratching our heads saying, 'Well, let's be safe.' "

As early as June 2000, Tacoma Power managers started plans to build bigger cash reserves and buying power for the winter. Seattle also bought some power for winter use. But Tacoma went a few steps further.

When the severity of the drought became clear in December, Tacoma managers fired up emergency diesel generators and jacked up rates 50 percent, the earliest and biggest rate increase in the region.

Tacoma took heat for raising rates so high, before the severity of the power crisis was widely understood.

"We started taking just tremendous abuse," said Steve Klein, superintendent of Tacoma Power. "I certainly wondered in December where Seattle and the other utilities were. Even my mom was wondering what I was up to."

But the strategy paid off. Rates and debt in Tacoma never went as high as Seattle's and are already headed down.

Drought as a factor

Seattle City Light is blessed with the bounty of three dams on the Skagit River and another on the Pend Oreille. Together they usually provide 60-70 percent of the utility's power needs with no pollution or fuel cost.

But hydropower is fickle. Hydro managers don't know exactly how much water they will have from one month to the next. Despite this, City Light assumes rainfall will at least be average. If it's not, the utility buys power to make up the difference.

Unlike some other hydro utilities, its planning models do not factor in low-water conditions.

Relying on the market instead made even more sense to City Light after federal utility deregulation in the 1990s left the Western energy markets awash in cheap power. In 1996 City Light shed half the power it gets from the Bonneville Power Administration and turned to the wholesale market to fill the gap.

Then, months before the drought of 2000-01 was apparent, City Light made another critical move toward market dependence: It sold its share of a coal-fired generating plant in Centralia, which provided energy for about 8 percent of City Light customers.

Environmentalists praised the decision and city officials boasted that power from a more environmentally friendly gas-turbine plant would be available in about a year.

Some other utilities that sold their shares bought Centralia's output from the new owners — TransAlta, a Canadian investor-owned company. City Light, on the other hand, did not immediately replace that power and instead upped its reliance on the energy markets again. And why shouldn't it? It could get cheap power on the market, even in a drought — or so the theory went.

More pre-drought trouble

There were, however, downsides to deregulation: Utilities feared it eventually could give customers the option of shopping elsewhere. That discouraged investment in new sources of power generation and purchase of long-term power contracts.

By 1999, the Northwest Power Planning Council was warning that increased demand and lack of new generation meant a one-in-four chance of winter blackouts by 2003.

Sticking to its reliance on cheap power markets, City Light in July 2000 expected to be 13 to 26 percent short on the power for fall and winter. But by the time those cold months rolled around, the second-worst drought on record in the Northwest was under way and the market was crazy.

The utility had to pay prices up to 30 times normal to fill shortages three to five times bigger than it had forecast.

Tacoma Power, on the other hand, planned its power needs on the basis of low water and has done so for years. It bought far less on the market.

Investor-owned utilities likewise had a conservative stance, knowing they faced a laborious process for any rate increases. Their customers paid higher rates year after year, but those rates included a cushion — insurance, really — against calamity for customers and investors. Puget Sound Energy customers, for example, have helped buy eight gas-fired turbines usually used only during the most power-hungry times of the day.

By contrast, City Light chose to self-insure through the years, taking the gamble that costs of buying power in dry years would be balanced out by surplus power sales in wet years. In the past it worked beautifully: Customers enjoyed some of the lowest electricity rates among large metropolitan areas in the country. And the utility had come through droughts before. The low-water year in 1992, for example, resulted in a 10 percent surcharge that was lifted in eight months.

"The punishment for being short (of power) has always been minimal," said Bob Royer, spokesman for City Light. "This time it was horrific."

Didn't see California signals

In August 2000, Seattle City Councilman Jim Compton, vice chairman of the City Light committee, waved a newspaper article at a council meeting. California was in the throes of price shocks and blackouts threatened. Might this maelstrom hit Seattle? Was there a way to buy power in advance to protect the city?

The California warning signs had multiplied consistently.

As early as 1997, California power supplies were squeaky tight, with the margin between calamity and stability on the California power grid at about half of what it should be. That margin was to grow ever tighter to the point of near blackouts in 2000.

Zarker and City Light managers assured Compton buying power was too expensive at that time. Prices would come down in the fall, when the weather started to cool off in California. And surely, if markets remained out of whack, the FERC would set them straight.

"We basically said, 'let's watch it,' " Zarker said. They bought a little, but didn't risk a big purchase. The danger of buying too much high-priced power seemed as acute as being caught short.

Others thought they better stock up.

"There was clearly some group thinking going on," said Jim Harding, former head of City Light's power planning and now director of external affairs. "They were more focused on models that had worked for the last 20 years than on reading the tea leaves in California."

Prices were indeed high and volatile, reaching almost $700 per megawatt hour at one point at the Mid-Columbia trading hub, the Northwest wholesale energy market that often moves in lockstep with California markets.

In October 2000, the Northwest Power Planning Council warned that high California prices that summer were not a passing storm, but a signal of a new market reality.

But City Light power buyers stuck to their old moves: relying on short-term purchases from the energy markets rather than buying contracts to cover needs far into the future.

As City Light managers predicted, prices did drop in November. But not for long.

Shopped at last minute

The price spikes that lay ahead would swamp City Light's trading in a way its managers didn't anticipate.

At its most basic, the utility's strategy was to buy power as needed. City Light bought half of its need about two months ahead of time, and the rest a few days or hours before it was actually used.

The system allowed fine-tuning in case dry weather cut supply from the dams or a cold snap turned on more electric heaters. The strategy also helped to avoid buying too much. Excess could be sold, maybe at a profit. But managers frowned on buying extra and selling it; that was speculation.

The strategy had a big downside, however, one that managers failed to adequately address during the crisis. If power supplies suddenly got tight, City Light had no reserves, except the water behind its dams.

Managers never considered how vulnerable their system could become in the new deregulated market. In a shortage, City Light would have to pay any price for power unless federal regulators intervened.

An audit of the marketing group in August 2000 gave the buy-as-needed strategy a clean bill of health. But the auditors and City Light staffers had never encountered shortages or prices like they saw in 2000-01. They considered a prolonged shortage with high prices very unlikely.

"Could we see a $350 (a megawatt hour) price coming? No way," says Zarker. "That was ridiculous."

Ran out of money

Still, Zarker knew the utility faced a big risk.

Back in May 2000, when the California crisis was jolting prices and City Light had sold its share of the Centralia power plant, he alerted the Mayor's Office, asking to buy some of the power needed for fall and winter — far in advance of normal.

The Mayor's Office agreed. But when City Light trader Don Tinker turned to the market in June to make the purchases, prices had jumped even higher. He bought only enough to replace about two-thirds of the power lost from the Centralia sale. Even so, the $21 million purchase, the biggest in the utility's history, tore a hole in the department's finances.

By late August, City Light was out of money. It went to the City Council to request authority to buy power, and proposed a rate increase. In those circumstances, it was hard to contemplate buying more power in advance. Managers agreed to buy a little more for the end of the year.

But in response to a memo to staff members outlining the decision, Zarker scrawled a caution: "Yes but use good judgment," he wrote on the margin. "See me if you think market conditions have changed significantly enough to warrant reconsideration."

It was the last extra power bought for the year.

Throughout the fall of 2000, City Light stuck with its buy-as-needed policy. That left it wide open when prices surged in December.

The storm hits

Prices shot to $3,683 per megawatt hour Dec. 11 when the Weather Channel predicted a cold snap in the Northwest. That turned out to be wrong, but the drought was for real. City Light's "perfect storm" was about to hit.

Days later, regulators issued a ruling with a common refrain: While prices in California and other power markets may be unreasonable, the FERC would not intervene.

"Those who remain in the spot market for buying their residual load," FERC commissioners wrote, "should be there in full recognition of the effects on price of last-minute sales and purchases."

By then Zarker's crew had to go last-minute shopping. In January, Tinker spent $56 million in two days buying power, the biggest spree in the utility's history.

"Anybody who had to act in early 2001 didn't have the option to do anything intelligent," Harding said. "We were doomed. All doomed. It was terrible at that stage."

Portland General Electric had bought for January 2001 two years earlier. Puget Sound Energy had January power locked up more than a year before. Tacoma Power topped off its January 2001 supply in October 2000.

In February, under pressure from the City Council and the threat of summer blackouts, City Light's resolve to not buy ahead cracked. From Feb. 27 through March 28, Tinker bought power for the summer and fall at prices between $300 and $465 a megawatt-hour.

"The council was seeing ... risk as this huge monster out there," said Tony Kilduff, the utility's risk manager. "Our exposure was endless."

In March, City Light borrowed $685 million in two bond issues, its biggest loan ever, and one that eventually led credit-rating agencies to downgrade City Light twice, more often than any public utility in the Northwest. City Light remains on watch for further downgrades.

In a final and expensive irony, prices started to fall just a few weeks later. FERC reversed itself and capped prices June 19, and the energy supply in California increased. Within a month power was available for $38 a megawatt-hour.

Instead of being short, City Light had locked up more energy than it needed. Now it is selling surplus for a fraction of what it paid.

Didn't fathom risk

City Light also grappled with internal confusion.

As late as March 2001, when prices were at record levels, Zarker gathered top City Light managers in his office to talk about how much to buy. But the finance, trading and generation departments each presented different forecasts for how much electricity was needed.

"This is basic," Zarker said. "We all have to be on the same page. Go away and deal with it."

The forecasts improved, and Zarker said the forecast discrepancies weren't a sign of imprecision, just a distraction.

Others say poor information was a more pervasive problem. "The lack of consistent appraisal of our situation was numbing," Harding said.

Harding, who had formerly run City Light's forecasting arm, says the myopia extended to the risks inherent in the trading strategy. "Our fundamental mistake was in not appreciating the magnitude of what we could be exposed to."

City Light managers defend their trading plan — and they haven't changed it. Kilduff, the risk manager, said procedures to prevent the same thing from happening again are still being hashed out.

"We're not convinced that if we had done things according to a different strategy we would have been any better off," he said.

Prices, not strategy, were the problem, Kilduff said.

"What we couldn't manage this time were prices that were 20 times their historical values in December 2000, and remained at nearly 10 times historical values for months on end."

Uninformed oversight

In Seattle, oversight of the utility is left to the mayor and City Council. The mayor can hire and fire City Light's superintendent; the council sets rates and policy.

During the energy crisis, City Council members were of little help. They lacked the adequate know-how to check the assumptions of utility managers, let alone outsmart the market.

"It's like sending your family to play on the freeway — it's inherently tremendously dangerous," Compton said of buying energy on the overheated markets.

At the same time, some suggest oversight of City Light might be better handled by someone other than local politicians, who are often distracted by other issues and not up to speed on utility matters.

City Light is the only municipal utility among the nation's 10 largest without an independent utility board to oversee its decisions.

"Maybe it is just selfish from my point of view, but it sure would have been nice (during the energy crisis) to have a group of people who were fully informed about the utility and the complexity of issues to bump ideas off of," Zarker said.

Alwyn Scott can be reached at 206-464-3329 and ascott@seattletimes.com. Lynda V. Mapes can be reached at 206-464-2736 and lmapes@seattletimes.com. Jim Brunner can be reached at 206-515-5628 and jbrunner@seattletimes.com.

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